The Demise of 6% Commissions?

Over the weekend, Damon Darlin wrote in The New York Times wrote about the doomed payment structure of the real estate industry.

Some economists wonder why agents fight so hard to maintain this pricing system when it is making so few of them rich. In every housing boom, the number of new agents entering the market tracks the climb in home prices. As a result, the average agent sells far fewer homes and makes less money. On average, agents earn $49,300 a year, according to the National Association of Realtors, and that is before paying for their own health insurance and retirement benefits.

“It’s a case where nobody wins,” Chang-Tai Hsieh, an associate professor of economics at the University of California, Berkeley, said of the current system. Mr. Hsieh, who has studied real estate commissions, said that they did not vary much from 6 percent and did not generally change in good times or bad. He said it was a form of price fixing, but an odd one. “Consumers pay a lot of money, and even the people who do the price fixing don’t win,” he said. “So it is a colossal waste.”

Traditional agents spend very little time brokering a deal, Mr. Hsieh added. Most of their time is consumed looking for new clients, which is of no benefit to consumers. An agent working for a salary, he said, would be freed of the need to prospect and would thus be more inclined to focus on negotiating.

Others agree. Steven D. Levitt, an economics professor at the University of Chicago, found that commissions did not align the interests of agents with those of their customers, a conclusion he recounted in his book “Freakonomics.” The agent has little incentive to get a few thousand dollars more for a homeowner, he wrote, because it will not much improve the commission. It is far more important for an agent working on commission to get the deal done and move on, he added.

A salaried agent is less likely to pressure a customer to make a deal, especially if the agent’s bonus depends on customer satisfaction, as at Redfin. Agents at that company, like Allie Howard in Seattle, are quick to point this out. “I don’t have to sell anything to the client,” she said.

New and quite possibly better payment structures are inevitably on the way. The article focuses heavily on Redfin, for instance. That’s exactly the type of business model that I believe will shake up the industry and ultimately bring about big changes in commission structure.

As I have stated before, I believe we’re headed for hybrids of the current model and these new models, in markets across the country. That said, I believe that there will remain a place for the traditional “full service” agent who brings more to the table than simply opening a door. After all, I couldn’t agree more that 6% is a hefty fee to pay someone to turn a door knob. I also believe that a segment of the population deosn’t want the “do it yourself” type of service and will continue to hire those with real expertise to handle their transactions soup to nuts. For example, those who invest their money with Sanford Bernstein are not the same as those who trade stocks on Ameritrade.

One thing to keep in mind, however is that it’s a mistake to set up any system that denies there is expertise in real estate. Certainly, the way things work now, plenty of real estate agents don’t have expertise, but that doesn’t mean expertise (in custom pricing, marketing, closing deals, helping sellers assess the quality of offers, etc.) isn’t real and valuable. Buyers and sellers will be doing themselves a disservice if they rush to a system that just makes the process cheaper–without giving themselves access to real, hands-on expertise.

To me the real driving force behind these changes probably isn’t even new technology, but consumers who are fed up that they are paying 6% and not getting all that much for it, in terms of expertise, service, and the like. That’s fixable–choose a different broker! You don’t have to wait for a new commission structure to do that. We have a whole podcast episode (it’s no an infomercial, I swear) with practical advice about how to choose a good broker.